Debt VS Equity Financing
Debt and Equity Financing are both very different ways of financing your SME business in Singapore.
Debt Financing means borrowing money directly from a lender, which consists of a loan that is to be paid back with interest.
Whereas Equity Financing involves selling a piece of the stake in your company to secure some form of financial backing, which is exchanging your company shares for the money.
Unless your business is backed by rich private investors or a family business with an existing empire of wealth to fall back on, chances are you will need some sort of financing to run your startup or business. Many business owners bootstrap their companies often using their personal credit cards to get things going.
There are more and more financing options for SME in Singapore lately, which include bank loans, alternative lenders, P2P lending, factoring companies and venture capital. With so many choices, sometimes it can be confusing about whether which to determine the right option for you or your business.
It is important to know the basics of these before you make a decision for your business.
Many Singaporeans are familiar with loans, whether you may borrow money to buy a house or car. Debt financing a business is pretty much the same. The SME, who is the borrower, get funds from a lender and promises to return the principal amount plus interest, on a regular schedule.
Some may require the towkay to pledge some assets like property and account receivable, as collateral, to provide some sort of reassurance. So in the event of any default payment, the risk from the lender will not be too much to bear.
Debt financing includes traditional loans like Working Capital loans, which have lower interest rates and longer terms but have a set of very strict criteria for approval.
It is very ideal for working capital purposes for the business - to purchase some new inventories or hiring new staff - which will avoid giving up any company ownership or equity in this case.
For most banks and larger financial institutions, they will usually not look at lending to companies who are 3 years and younger, as providing loans to new companies does not make a lot of sense in that the lenders will carry the same risk as of an equity investment but doesn’t offer the same upside in terms of returns. They can receive relatively low returns from interest payments only, which stands a chance of total capital loss.
It is not as popular as compared to debt financing for SME business owners in Singapore. But however, more and more tech startups are going into this avenue, unlike the brick and mortar businesses as such deals are often dealt with through a venture capitalist or equity crowdfunding companies.
This process is whereby raising capital, or money, through the selling of shares in a business. Therefore, there will be ownership interest for the relevant shareholders. It may just be a hundred of thousand raised through a private investor or up to a couple of millions in an IPO.
Investors usually look at these types of businesses with the potential to grow rapidly with just the capital investment to do so. These groups of investors are highly experienced and discerning and therefore will not just throw their large sum of money on any type of business. To say all these, business owners have to show set of projected strong financials, innovative working products or services, and a very qualified management team.
The good thing about getting equity financing is that the financial risk of the business is distributed out among a large group of rich investors. And when the business is not profitable at a period of time, they do not have to worry about making monthly repayments. Even if the business fails eventually, none of the money needs to be repaid.
It may seem the ideal type of financing. However, owners must be careful of selling their amount of shares. If your shares are relinquished more than 49% of your business, you will, therefore, lose the majority stake and rights in your company. It means that you will have lesser control over your own company operations and risk of removal from the top position in your own company if the shareholders decide to change leadership.
The Bottom Line
The decision between taking up debt or equity financing depends on the nature of your business, and whether the advantages outweigh the risks. If you do not know how to make a decision, it is advisable to do some research within your industry and check out what your competitors are doing as well.
You can even use the formula, Weighted Average Cost of Capital, to help you make a better financing decision for your own company.